Krugman’s Latest Debt Denial: Why His Two Magic Numbers Don’t Cut It

Professor Krugman is at it again—–conjuring fairy tales about a benign long-term fiscal outlook. Notwithstanding that the public debt has surged from 40% to 75% of GDP during the six short years since 2008, he claims there is no reason to fret and that there is no debt spiral anywhere in the future. In part that’s because the Keynesian priesthood has declared that interest rates have down-shifted on a permanent basis. CBO has therefore dutifully incorporated this assumption into its long-term projections:

This (interest rate) markdown has the effect of making the budget outlook — which was already a lot less dire than conventional wisdom has it — look even less dire. But there’s a further point worth emphasizing: the CBO has just declared an end to the debt spiral.

Even accepting CBO’s “rosy scenario” outlook (see below), it’s not evident that it has declared an end to the debt spiral. In fact, it projects publicly-held treasury debt to soar from $12 trillion today to about $52 trillion by 2039. Most people would judge that a spiral.Indeed, as shown in the CBO graph below based on “current policy”, the public debt ratio is heading sharply upwards to more than 100% of GDP.

So how does professor Krugman turn this dismal chart into an “all clear” reassurance–when it actually shows public debt heading to above WWII levels at a time when the baby boom is at peak retirement? Well, it seems that Krugman unearthed two numbers in a 182 page report that purportedly render harmless the $52 trillion of bonds, notes and bills that CBO projects will need to find a home at the historically low interest rates it forecasts for the next 25 years.

So we turn to Table A-1 on page 104 of the CBO report, and we learn that for the next 25 years CBO projects an average interest rate on federal debt of 4.1 percent and an average growth rate of nominal GDP of 4.3 percent. And this means no debt spiral at all.

A GDP growth rate higher than the average carry cost of the public debt sounds all good, but here’s the thing. Given outcomes during the 21st century to date, there is simply no plausible reason to believe that nominal GDP can grow at a 4.3% CAGR for the next 25 years. In fact, since the pre-crisis peak in early 2008, nominal GDP has grown at only a 2.5% CAGR, and even during the last two years when “escape velocity” was expected any day, the compound growth rate has been only 3.0%. Indeed, during the entire 14 years of this century—encompassing nearly two complete business cycles—-nominal GDP has expanded at just 3.8% per annum.

Needless to say, when you are crystal balling a quarter century ahead, CAGRs make a big difference, and that’s profoundly true of the Federal budget. Specifically, revenue is highly sensitive to nominal GDP growth because it is always money income, not real GDP, that is on the radar screen of the tax-man.

Thus, owing to the miracle of compounding under the CBOs 4.3% CAGR, nominal GDP is projected to amount to about $49 trillion by 2039. By contrast, if money incomes grow at a 3.3% CAGR, or at the upper end of the last seven year’s experience, nominal GDP a quarter century forward would be only $38 trillion. And at CBO’s 19.4% of GDP tax take on the $11 trillion difference—-that’s nearly a $2.0 trillion annual revenue shortfall by the terminal year.

At the same time, the spending side will be driven by the soaring social insurance tab for retiring baby boomers during the decades ahead, regardless of nominal GDP. Accordingly, CBO forecasts that outlays for Social Security and Medicare will rise from 8% to 11% of GDP during the next quarter century, and that this will cause primary Federal spending (i.e. ex-interest expense) to grow at a 4.8% CAGR.

But that’s where professor Krugman fairly tale of two magic numbers hits the shoals. Based on the above demographic/social insurance dynamics, CBO projects that non-interest Federal spending will rise from $3.3 trillion this year to about $10.3 trillion by 2039. Yet were nominal GDP growth to track the lower 3.3% CAGR suggested above, there would be little off-setting reduction in the primary spending path.

That is especially the case because CBO’s forecast continues to embody a modern version of “rosy scenario”—that is, it assumes that real output will grow at a 2.3% CAGR for the next 25 years. Yet that ignores the numerous and compounding headwinds lurking down the road. These include baby boom demographics and the massive overhang of $60 trillion of public and private debt domestically; and global troubles everywhere—from the bankrupting old age colony in Japan, to the tottering house of cards known as “red capitalism” in China, to the crushing burden of the socialist welfare state in Europe. Given these adversities, there is no reason to assume that US real growth will sharply accelerate from the tepid trends of the recent past.

To wit, real GDP has averaged only 1.0% annually since the pre-crisis peak in early 2008, 1.5% during the last 8 quarters, and just 1.8% during the last fourteen years—including the false prosperity of the Greenspan housing and credit bubble after 2001. So why will GDP growth accelerate by nearly one-third for a quarter century running—when even under CBO’s own forecast, labor force demographics will turn sharply negative in the years ahead?

Whereas 1.0-1.5% of annual real output growth during the second half of the 20th century was accounted for by labor force expansion, CBO projects this foundational component will drop to just a 0.5% annual rate during the next several decades. This demographically baked in reality, in turn, requires CBO to project that labor productivity will rise by 1.8% annually in order to meet its 2.3% output growth bogey.

But that just can’t happen. During the next 25 years the US economy will be shedding its most productive labor—which is to say, the now aging baby boom work force. At the same time, the US economy will also be laboring under a severe, cumulative deficit in domestic investment in productive plant and equipment—the sine quo non of future labor productivity growth. Since the turn of the century, in fact, real CapEx growth have averaged only 0.8% annually, or hardly one-third of its prior historical rate; and the true measure of future productivity growth— net investment in real plant and equipment after capital consumption allowances—has actually declined by 20% since 1999-2000.

Real Business Investment – Click to enlarge

In a word, the shortfall from CBO’s 4.3% nominal growth scenario is likely to come almost entirely out of the “real” component of GDP rather than its 2.0% GDP deflator assumption. This means that nominal Federal spending would likely remain consistent with CBO’s projections as outlined above (i.e. COLA adjustments would be about the same), and could possibly rise considerably higher due to a larger caseload of safety net beneficiaries.

The baleful bottom line is this. Under the CBO’s rosy scenario, the primary Federal deficit by 2039 is just under $1 trillion annually or a modest 1.8% of GDP, meaning that the primary deficit is not fueling an uncontrolled debt spiral. By contrast, under the 3.3% nominal GDP scenario with realistic assumptions about labor productivity and real growth, the primary deficit would soar to nearly $3 trillion annually, and reach 7.5% of GDP.

It goes without saying that a primary deficit that massive would fuel a hellacious debt spiral—the very opposite of the benign outlook espied by professor Krugman. Rather than the 106% of GDP already built into the CBO forecast, the public debt over the next 25 years would literally spiral off the charts. We would end up exactly in the fiscal briar patch that professor Krugman so insouciantly mocks:

… because people will fear that we’re about to turn into Greece, Greece I tell you.

So talk about unjustified complacency with respect to the public debt spiral! The best outcome we can imagine per CBO’s rosy scenario case is a clearly dangerous level of public debt relative to GDP. But the probable path under sober economics is orders of magnitude worse. Indeed, with primary debt accumulating at a nearly double digit rate against GDP, the CBO’s average 4.1% interest expense assumption would give way to higher rates, meaning that neither of professor Krugman’s two magic numbers cut it. Under a regime of even modest monetary normalization over the next quarter century, current fiscal policy will lead to interest rates that are far higher, not lower, than the growth rate of nominal income.

So its time to put Greece right back into the front and center of the US fiscal picture, I tell you!

BTW, was at a doctor's appointment today and a lady administering tests paused and asked, out of the blue: "Do you think the markets are rigged?" I mean, she didn't know me, didn't know what I do and was talking about selling some of her stocks and buying bonds and gold. I mean, this is a senior nurse/lab technician. Huh?Everybody knows there's something radically wrong. Doesn't matter what they think it is, but they KNOW it's just not right.

Yes Yen, she gave me her best wishes....But no ObungaBill for the Knukies. Knukies has paid for his very won healthcare for some 20 years now. And his insurance is unassociated with the abortions promulgated under the ACA and its various offerings. Which as today's appointment was by referral from primary stupendously awesome care provider, was preceded with a single question. "Is your insurance CoveredCalifornia?" Should one answer said question in the affirmative, many doctors' services (as in lots and lots) are in the negatory, mate, pay cash realm out here in the Land of Free Shit. So said First Lady Prodded and Poker was indeed kind and gentile, as she was confident her services today were being justly remunerated.

Oh yeah, I did go long concierge medicine with this doctor. She's ministered and tended to me going on 10 years, and in fact was called by Mrs K the very day we did our admission to the local hospital for out first steps, so to speak. So she's been with me from day 1, now closing in on ten years clean and sober.... and she even sends prospects my way to sponsor a la te 12 step calls from the old days. Exceptional stuff..... She's a shining star in the

area mediacl community and is one of the last private practice admitting and attending physicians about the area. So I see her same day calls, she sees me after check in to hospital. Very well thought of and has major presence. Was one of the absolute best medical expenditures I ever did.

Yes, I have a real family doctor, circa 1930's come to the house, at the hospital, etc. Brilliant niche management.

Sadly however, is the increasingly fractionation of level of services that is happening in part due to ACA, etc. The poor with the state and federal plans have lesser choices. Etc, etc, etc..... But this is the way it is, and the way it is, is good.

benzodiazepam (Valium and its sisters do induce incoordination like alcohol. Opiates usually don't though they may induce drowsiness (though often a hyperactive state in some people). Stay away from anything you do not need but recognize the true risks and benefits of meds.

Right now the feds are trying to cut off alot of meds that some people really need (for the children). Opiates are on the list. They have also completely screwed up the distributioon system. I cannot get normal saline, the basic salt water solution is most IVs. There has been a shortage for months!!! It salt and water for gods sake!!

These are the folks we trust our lives to and they are screwing up badly. People will continue to die. The events at the VA hospitals made the news first because they have the most government influence. Wait til your kid cannot get antibiotics when really needed...or seizure meds. These are heartless people who simply do not know their limits and do not care.

aw, many of those Jews could care less about the Israeli state. Ditto for the WASPs. Not a lot of Christian Zios in there, of course... basically you're talking oil, MIC, banks... their religion is money and power.

Now the US Congress - Zionist Jews own the fuck out of them. MSM, too, by both direct and indirect means.

DIA.... now that's a wild card.

ZH covered it already a bit but it deserves much more coverage, Feinstein's bill to funnel shit to NSA ergo Israel... she's a good old fashioned sayan, and those few loyalists left ought to spend some time contemplating the little lady's avocations, I'd imagine.

Krugman sure has a great gig IMHO. He can say anything and people just swallow it up and believe it lock-stock-and-barrel every time he gets published. Thank God Z/H sees through the ruse every time as well.

I read recently that smelling my farts can help prevent me getting cancer. Now that they have a value as a preventative treatment for cancer I can sell them - my farts have value. Can't wait to rehypothecate them.

Logged on to say there aren't three people who give a horsefuck what Krugman has to say. One works at the NY Times (if you can call lying for a living work), one works at CNBC (ditto) and one seems to be pulling copy at ZH. Logging off now.

The typical schizophrenic lives in a world of twilight imagining. Marginal to his society, incapable of holding a regular job, these people live on the fringes, content to drift in their own self-created value systems. TM

Who is going to be left to pay taxes in 2039? We know the corporations won't be. I have a feeling automation will be invested in to its fullest and the social welfare state as we know it will have a lot more hungry FSA to feed.

I'll defer to you economics egg heads... or at least won't attempt to argue in-paradigm, but I think the 'as % of GDP is wildly misleading for a couple reasons...

how gdp is measured, what it fails to account for internally in terms of disposible income and debt service and loss of purchasing power/cost inflation, mass unskilled immigration plus outsourcing plus worsening schools,

actually a bunch of things. In baseball terms, it's like W.A.R. - to some sabernerds, it is a thing of unique beauty... to those with a foot firmly in the real world, it is a formulat which is simple, elegant, and meaningless in terms of predicting a damn thing.

Krugman is correct in a sense. Nominal GDP will grow at 15% while real GDP will be down -5%. That leaves inflation at 20%. Problem solved. Look at Argentina. Their total debt to GDP shrunk massively thanks to very high inflation. OK the Peso went to dust but the objective of reduction Debt to GDP was achieved.

Austerity is a term that recently has been given all kinds of negative connotationsbecause it is often painful.Economic growth tends to mask a multitude of problems, in economics austerity refers to cutting spending often by lowering and reducing the amount of benefits and public services.

Austerity policies are often used by governments to try to reduce theirdeficit spending. Spending cutbacks are sometimes coupled with increases in taxes in an effort to demonstrate long-term fiscal solvency to creditors.It is easy to point your finger at measures taken to reduce runaway or wasted spending and blame them for creating a reduced spending spiral but that is unfair. More on how Austerity has been given a bum rap in the article below.